So often on the popular hit series ABC’s Shark Tank, entrepreneurs and investors have been at odds with regards to what that company is really worth. The business owner will see his or her company worth millions based on sweat equity while the investors looks at tangible factors like earnings, sales, and market share before committing any cash equity.
As a startup, how best can one determine a valuation (what that company is really worth) when pitching to investors? BlackEnterprise.com contacted members of Young Entrepreneur Council (YEC), an invite-only organization comprised of the world’s most promising young entrepreneurs. In partnership with Citi, YEC recently launched StartupCollective, a free virtual mentorship program that helps millions of entrepreneurs start and grow businesses.
Here are 10 tips for best determining your company’s valuation:
1. Look to the Market
As a first time entrepreneur, I was clueless as to valuing my company. Luckily, I had the mentors at gener8tor to help me set an initial valuation ask for the business. After that, the market (investors), will help fine-tune the valuation to what is fair. Keep in mind that where you raise money (midwest, Silicon Valley, west coast, etc.), has an impact on the valuation too.
– Andrew Hoeft, Pinpoint Software, Inc.
2. Research Comparables
Early-stage companies, especially those that are pre-revenue, should extensively research comparable firms in the market who have successfully raised funds. Based on the funds raised, you can assume a certain dilution to arrive at a reasonable valuation. When you do this exercise across ten or more companies in your market, you can have more confidence in the valuation you set for your firm.
3. Don’t Fall Into the One Percent Trap
Silicon valley veteran Guy Kawasaki always refers to the key misstep that entrepreneurs make as the one percent trap: taking one percent of really large numbers and then asking, “how hard can one percent be?” Assuming you will have one percent of a market right away might be the biggest contributor to overvaluation. Don’t assume anything without researching feasibility, no matter how easy it may seem.
– Brian Honigman, BrianHonigman.com
4. Base It on Profits, Not Revenue
If you had $100,000 in revenue last year, your company is worth 1 to 1.5 times that. This depends on your growth trend and whether your company relies on you. The owner-hit-by-a-bus theory is relevant here. Base your valuation on profits so you look more savvy. The investors will usually only go to about eight times profits.
– Joshua Lee, StandOut Authority
5. Don’t Let Your Emotions Affect Your Valuation
When we appeared on the first episode of the first season of “Shark Tank,” we definitely overvalued our company, College Hunks Hauling Junk. We had a few hundred thousand in profit at the time, but we asked for a ridiculous valuation. Turns out in hindsight we really weren’t prepared to give up equity because we were emotionally tied to our startup. Startups need to ask themselves what they really want and at what cost. But they must be realistic in their expectations.
– Nick Friedman, College Hunks Hauling Junk
6. Don’t Rely on Yourself to Determine Your Company’s Value
The marketplace of investors must determine startup value. That means meeting with enough potential investors to fully understand market signals. It may also mean deferring fundraising until the market shows enough interest for the price to be in line with expectations. Shows like ABC’s “Shark Tank” tend to corner the entrepreneur into accepting a non-market valuation for their company.
– Noah Glass, Olo
7. Use the Discounted Cash Flow Method
Project your financials for the next five years and use the discounted cash flow method. This system isn’t perfect, but it shows you’ve thought through your numbers and can back them up. It’s not as hard as it sounds either. An easy way to project earnings is to use a standard growth rate that has been proven or can be defended. You can use a DCF calculator online to back into your valuation.
– Robert De Los Santos, Sky High Party Rentals
8. Go Bottoms Up
Given
the fact that it is a startup and more than likely has no cash flow, strategic partners or brand recognition, the best way to come up with a pre-money value is to assign a value ($0 – 1MM+) for each bucket: How experienced is the management team? Is there a cash flow? Is there a working version of the product? How large is the potential market? Do they have existing partnerships?– Joseph DiTomaso, AllTheRooms
9. Ask Yourself What You Would Sell For
In a startup with little or no cash-flow, valuation is a subjective, psychological target. After modeling your financial projections, one trick is to figure out the valuation that you wouldn’t feel badly giving to your friends and loved ones, but that you would also feel good about. But when it comes down to it, you own the shares. What would you sell a piece of your opportunity for?
– Miles Jennings, Recruiter.com
10. Understand Multiple Methods
Understanding how multiple methods work helps ensure you can speak the same language as investors. This also lets you establish a range of valuations and may help you have realistic expectations.